Are You Misclassifying Workers? Why It Matters More Than You Think

The true cost of getting it wrong—financially, legally, and culturally.

If your business hires freelancers, consultants, or part-time help, there's a question you can't afford to ignore: Are you correctly classifying your workers?

At first glance, labeling someone as an independent contractor instead of an employee might seem like a simple administrative decision. But misclassification—whether accidental or intentional—can expose your business to serious legal, tax, and financial risks.

And in today’s regulatory environment, state and federal agencies are paying attention.

Here’s what business owners, HR leaders, and finance teams need to know about worker classification—and why getting it right is more important than ever.

What’s the Difference Between an Employee and an Independent Contractor?

In basic terms:

• Employees (W-2) are under your control—you dictate how, when, and where they do their work. You’re responsible for withholding income taxes, Social Security, and Medicare, and possibly providing benefits like health insurance or PTO.

• Independent Contractors (1099) are self-employed. They set their own schedules, use their own tools, and typically work with multiple clients. You pay them a gross amount and don’t withhold taxes.

Seems straightforward—but in practice, it’s often a gray area.

Why Misclassification Happens

Many businesses—especially startups and small companies—default to classifying workers as contractors to:

• Reduce overhead and payroll taxes

• Avoid providing benefits

• Simplify onboarding

Others simply aren’t aware of the nuanced legal criteria for classification. The problem is, intent doesn’t protect you from liability.

The Consequences of Misclassification

Misclassifying workers can trigger a host of consequences, including:

🚨 IRS and State Penalties

• Back taxes, interest, and penalties for unpaid payroll taxes

• Fines for failure to file correct tax forms (W-2 vs. 1099)

• Possible audits or investigations by the IRS or state tax agencies

⚖️ Wage and Hour Violations

• Claims for unpaid overtime, minimum wage, or missed breaks

• Retroactive benefits owed (e.g., sick leave, vacation, unemployment insurance)

• Potential class-action lawsuits if multiple workers were misclassified

🧑‍💼 Loss of Trust and Reputation

• Legal disputes can damage employer brand and erode team morale

• Correcting misclassification retroactively may create confusion or resentment

In some high-profile cases, businesses have faced multi-million-dollar settlements over worker misclassification—including companies in tech, logistics, and gig work.

How to Classify Workers Correctly

1. Use the IRS Common Law Test

This test examines three key areas:

• Behavioral control: Do you direct how the worker performs their job?

• Financial control: Do you control payment terms, expense reimbursements, and provide tools?

• Relationship type: Is the work ongoing? Do you provide benefits? Is it a core business function?

The more control you exert, the more likely the worker should be classified as an employee.

2. Check for State-Level Rules

Some states apply stricter standards. For example:

• California uses the ABC test, which assumes a worker is an employee unless all three of the following apply:A. The worker is free from control and directionB. The work is outside the usual course of your businessC. The worker is independently established in that trade

Even if you meet federal guidelines, you may still violate state laws.

3. Review Contracts and Daily Practices

Even if a contract says "independent contractor," what matters is the actual working relationship. Courts and regulators will examine what happens day to day—not what’s written on paper.

What to Do If You’re Unsure

If you’re unsure about a worker’s classification, don’t guess. Instead:

• Consult with a qualified HR advisor or employment attorney

• File IRS Form SS-8 to request an official classification determination (note: this takes time)

• Err on the side of caution—if you control how work is performed, treat the worker as an employee until proven otherwise

And if you discover you’ve misclassified workers? Address it proactively. Voluntary correction programs exist, such as the IRS Voluntary Classification Settlement Program (VCSP), which may reduce penalties.

Final Thought: Compliance Is Culture

Correct classification isn’t just about avoiding fines—it’s about respecting the people who help your business succeed. Treating workers fairly and transparently reinforces a culture of trust, accountability, and long-term growth.

Need Help Navigating Worker Classification?

If you're unsure how to evaluate or correct worker classifications, MCDA CCG, Inc. is here to help. Our team of HR and compliance experts offers clear, strategic guidance tailored to your business structure and state regulations.

We help business owners avoid costly mistakes—and build stronger, more compliant organizations in the process.

👉 Let’s get it right, together. Contact MCDA CCG, Inc. to schedule a consultation.